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China's Growing Pains
Many of the bulls on China are bears on the world. They fear that today's great economies will be eclipsed by the mainland's growing wealth and power. Many tout populist notions of unemployment and capital flight from Western countries. But a sober look at the facts easily dispels these tropes.
China is affecting the global allocation of labor and capital. This is no surprise. Whenever a new, dynamic economy emerges from underdevelopment, there will be changes felt around the world -- otherwise England would be full of cotton mills; Belgium, a major coal-producing nation; and Japan, still a manufacturer of transistor radios. China's growth, from this perspective, follows a natural pattern of comparative advantage. As countries graduate into low-end manufacturing industries, traditional producers move to higher value-added products. But this is never a zero-sum game: Total global output, jobs and wealth all rise as a result.
That's hard to see when China consistently posts enthralling percentage gains in every economic domain. But focusing on these figures can be misleading. A big percentage of a small number is still a small number, while a small percentage of a big number is still a big number. For example, 2% annualized growth in the U.S. or European Union economies produce the same dollar-increment in output as 10% growth in China. China's "takeover" of the world a tough task indeed.
One way of quantifying China's potential growth is to compare its total factor productivity (TFP) -- the increase in output per unit of input of capital and labor. If the supply of capital and labor were kept constant, this is the speed at which an economy could grow. Over the last decade or so, China's TFP has averaged 3% annually, while the U.S. averaged 1.7%. Based on this measure, Chinese productivity has been increasing almost twice as fast as that of the U.S. Still, in order to reach a comparable economic size, the mainland would have to continue pouring more capital and cheap labor into the economic "wok." But the reality is that this task won't be possible to the same extent it's been in the past.
Until recently, China's development model mirrored that of other emerging Asian economies. It's based upon cheap capital, engineered through forcing consumers to save for their own pensions and to provide for their own social security, then using those savings to fund cheap credit on capital expenditures. That's how emerging economies in the Asian region produced massive investment in manufacturing exports and prioritized growth over all other objectives.
This model is now past its sell-by date. First, China's supply of labor isn't limitless. The mainland's working population will grow by a mere 0.5% per annum between now and 2009. After that, it will start to shrink, falling by nearly 1% annually beginning in 2014. Skill shortages may already be pushing up wages. In China's eastern seaboard factories, which produce 85% of China's exports, wage levels are already equal to those in many Eastern European countries poised to enter the EU. Just over the border from Hong Kong, Shenzhen factory wages now exceed some large Asian competitors in India and Indonesia.
The days of cheap capital are numbered, too. Capital is the gas in the fuel tank for the Chinese economy. In 1992, it took two units of capital investment, or "gas," to produce one unit of national output. Now, it takes 5.5 units of capital. In other words, mileage per gallon has been falling. Take the the textile dyeing industry, which used to get its land virtually free from local government and was not even required to have a water treatment plant. Now, at least in the developed western provinces, it has to buy the land and clean its effluent. As a result, measured on the narrow basis of output, China's capital efficiency has been falling as its growth rate accelerated. In the future, capital will become scarcer, but more productive, as China becomes a consumer society with lower household savings rates.
China's leaders recognize these problems. The New Economic Model, crafted by the national legislature in January, aims to boost domestic consumption and create more sustainable growth. This can only be achieved through a reduction in China's enormous domestic savings -- a tough task when pensions and other social safety nets are nonexistent. The Chinese economy will also have to shift from the manufacture of tradable goods, such as assembly of electronics, to nontradable goods such as service industries. This will take time: Employees need to be trained and consumption, stimulated.
Given these constraints, China's maximum sustainable growth rate over the next two decades will likely average approximately 8% in inflation-adjusted terms. China's rising wealth, as well as the switch from tradable to nontradable sectors as its engine of growth, may also cause a rise in the yuan's real effective exchange rate by about 1% annually. Under these optimistic assumptions, China would grow over three times faster than the U.S. and OECD countries, in today's dollars.
Even so, after 20 years, the absolute gap in China's GDP per capita versus the U.S. would be 10% larger than it is today. Of course, the Chinese would be richer; living standards would rise six-fold. But the average American would have increased the gap in wealth over the average Chinese because he will start the next two decades on a wealthier footing. Total household wealth in China would still be worth only one-third that of the U.S., despite a continuing superior savings rate.
Together, costlier labor and capital will eventually curb China's growth rate. The impact will be felt most in China's ability to increase its share of global trade in manufactured products. Furthermore, the switch from mass manufacturing for export to a more domestic, service-based economy will take time -- and call for the sort of individual creativity that even relatively sophisticated economies such as Singapore have difficulty developing. China may be growing fast, but it's not a world power just yet.
From: Wall Street Journal, By DAVID ROCHE
Date: November 16, 2006 Back